Outlook: Default Deja Vu

Kathleen Day
Spokeswoman, Center for Responsible Lending
Monday, June 2, 2008; 12:00 PM

"As a reporter for this newspaper, I covered the savings and loan mess in depth and later wrote a book about it. Watching the current crisis unfold, I see much of the same behavior that led to the "S&L Hell" of two decades ago. ... Once again, too many people had access to other people's money with too little oversight. Once again, the White House, Congress and federal bank regulators failed to police the financial services industry because they mistook deregulation for a system without any reasonable rules. And now as then, our saga is chock-a-block with people and institutions deserving special mention in the Subprime Hall of Slime."

Kathleen Day, a former Post reporter who is now spokeswoman for the Center for Responsible Lending, was online Monday, June 2 at noon ET to discuss her Outlook article on whom to blame for the subprime crisis, and to offer suggestions for how the government can actual fix the problem this time around.

The transcript follows.

Archive: Transcripts of discussions with Outlook article authors


Kathleen Day: Hello. I'm looking forward to taking questions on the mortgage mess. Please fire away.


Waldorf, Md.: Alan Greenspan is oft quoted talking about "incremental" rate rises being incapable of "bursting a bubble." Use of the term "incremental" rationalizes the Fed's ridiculous series of 25-base-point increases. Has anyone asked Greenspan why his Fed didn't raise rates more quickly to squelch the out-of-control housing market? Would larger moves have had any effect on the "bubble"?

Also, your piece does a nice job of detailing the abuses of the corporate entities, but seemed to ignore the rampant greed and lemming-like actions of the homebuyers and sellers. Just because a bank tells a buyer that the buyer is approved for $500,000 does not mean that the buyer must use every penny of that commitment. In your opinion, what role did the homebuyers and sellers have in this mess?

Kathleen Day: I don't believe most of the borrowers caught in this mess were getting $500,000 loans and buying McMansions -- that's what industry wants you to think. Sure, there were some speculators -- estimates range as high as 10 percent -- but most of the people live in their home, and most of these loans were for refinancing an existing home loan, not buying a home for the first time. And most of these loans were aggressively sold -- the lender, often by way of a broker, came to them, knocked on their door, called them up and persuaded folks they could get some equity out their home for other things, like paying credit cards etc. These for the most part were low- to moderate-income folks who believed the financial advisers -- their lender or broker -- that they not only could afford the loan but could refinance when it became unaffordable. While there's lots of evidence that incomes, etc., were inflated, there's lots of evidence that the brokers and/or lenders did this without a borrower's knowledge.


Alexandria, Va.: You touched on the crux of the matter in your article a couple of times. Bush wanted immigrants (including illegals) and minorities in general to own their own homes. So for the high percentage of those folks who did not have good credit ... that had to be overlooked. To pay attention to such negative elements would be bigoted, racist, xenophobic ... the insults go on and on. Who would subject themselves to such calumny? Just look the other way. That goes from bottom to top -- the agent, banker, wall-street, international banker, federal reserve, president. No one wants to have the word "racist" hurled at them. So the economy collapses. Not too high a price to pay to be politically correct.

Kathleen Day: I wouldn't say it's politically correct to disproportionately target black and Hispanic/Latino families. I would say the fact that these families were targeted has been ignored by Congress and the White House. No one wanted to say it was all a house of cards because too many people were making lots of money in the short-run, leaving the rest of us to pick up the pieces, including the enormous cost.


Washington: How much do you foresee prices in the Washington metro area correcting? Do you feel that many banks, appraisers, lenders or agents in this area contributed to the ridiculous appreciations in this area? If any are found to have used falsehoods, what should the penalty be for their transgressions?

Kathleen Day: Certainly there are many counties in Maryland, Virginia and the District where home prices, or rather the rate of increase in home prices, was inflated by all concerned. Unfortunately these areas tend to be lower- to middle-income neighborhoods, so no, all areas in the D.C. region are seeing home prices decline, though probably all will see prices stop appreciating for a time. As for punishment, I leave that to law enforcement at the local level and at the Department of Justice. Common sense says the problem can's be ignored, but the tragedy is that law enforcement should have been on the scene sooner, which might have prevented some families from losing their homes.


Solebury, Pa.: I have read a lot on this topic, and I think you are correct -- certain people on Wall Street profited enormously from securitization of junk mortgages, all the while knowing that eventually it would go bad. I don't think they realized how bad it would get, but nevertheless, they collected big money with little or no potential legal jeopardy, and now we all will pay (and many who will pay did not directly or indirectly benefit from the real estate boom). This kind of thing has happened numerous times in the past 100-plus years in this country, and regulation never has stopped it. Is regulation the answer, or are we doomed to these booms and busts?

Kathleen Day: It's not deregulation necessarily that's at fault, but when you allow people in the financial services community to offer more or new or different services, the army of regulators at the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and all the other federal agencies, as well as at the state level, have to supervise -- that is, make sure everyone's playing by the rules. When things get busy, you simply need some traffic cops. Unfortunately, the regulators have acted more like cheerleaders for industry rather than for borrowers.


Hyattsville, Md.: Kathleen, this is just another case of privatized profits and socialized risk.

Kathleen Day: You are absolutely right -- many of the culprits here have been given multibillion bailouts even as they wail against helping the borrowers caught in this mess. I hear much talk about personal responsibility but don't hear the perpetrators taking any. This is also a case of drinking the Kool-Aid -- securitization and derivatives, etc., are complicated financial instruments that when used correctly allow an investor to manage risk. In this case, those high-paid Wall Street lenders and investors misunderstood their own products and came to believe these complex instruments did away with risk -- or maybe they knew very well the risks but, because they could pass the buck by selling this stuff, they didn't care. The losses financial institutions have suffered in some cases can be attributed to their being stuck with this junk because the music stopped before they could unload it.


Alexandria, Va.: Just a comment -- I filed bankruptcy in 2003 because of a large hospital bill. Just for the heck of it, I wanted to see if what if anything I was eligible for in 2006 for mortgage (this was through HUD-approved lender list for first-time homebuyers). I was told by the lender that I was eligible for a subprime loan. Could I afford the payments? Sure, and still have money to live off, as I also had no other bills.

However, I know the repercussions of subprime loans. My lender, however, did not mention anything about what it could mean to take out such a loan if my rate would (as they usually do) go up. Also, as a person of color -- who is usually on the mostly likely victim list (even though we only spoke on the phone) -- I still bristle every time I think of it.

It just highlights that loans are not written in languages that even attorneys understand oftentimes, so forget most commonfolk getting it -- and companies that can make a profit never will police themselves, because it's not in the best interest of the bottom line. Still an apartment dweller (and thanks for letting me rant).

Kathleen Day: I would love to get all the CEO of the companies making these loans and buying and packaging them as the top regulators and -- without letting them prepare -- put them in room and have them try to decipher and explain the documents the high-pressure salesmen were coaxing borrowers to sign. You can be sure they wouldn't be able to make head or tails of any of it


Princeton, N.J.: Richard Clarke was on C-SPAN this morning touting his book, "The Failure of Government". He says that one of the problems is that certain words and ideas behind them have been demonized. Words like "taxes", "bureaucrat" and ... "regulation." That various industries have prevented necessary regulation. That the administration consistently has appointed members of the industry to be regulated to the board that does the regulation. Isn't the mortgage crisis just another example of this process?

Kathleen Day: The regulators are too close to the industry. They will say having robust financial institutions is essential to the economy's well-being and therefore society's. That true, but they have failed miserably by that standard. They use that as the excuse not to impose rules when everyone seems to be making money, and they use that as an excuse to bail out industry when it drinks and drives and hits a brick wall, running over a few people in the process. Regulators and Congress, which failed in its job of overseeing the regulators, all buy into whatever industry's doing if it's making money and campaign donations. But they aren't looking at the long-term health of the economy to make sure what seems to be profitable in the short-run is really healthy in the long run. Individuals account for well over half of economic activity; when you treat individuals unfairly and contribute the economic ruin of millions of consumers, it's no wonder credit ground to a halt. This was simply a kind of business that was good for a few in the short run and bad for everyone in the long.


Fairfax, Va.: I am a mortgage lender. My company had 12 loans go into foreclosure this past year. All of these loans were from speculators or from borrowers who lied about their incomes. None were full-documentation, owner-occupied loans. One of our defaults was a "McMansion" valued at more than $800,000. We later found out the borrower made $54,000 a year, not the $200,000 he put on his loan application. Stated-income loan programs were wrong, but I think there are a lot more foreclosures caused by "borrower greed." The general public and the media have not done a good job of grasping this issue.

Kathleen Day: Excuse me, but isn't it your job to verify income? You say stated income was wrong in a parenthetical way when in fact that's at the center of this. For every McMansion-buyer you have as an example there are dozens of small-home buyers who are losing their homes. One example: In Palm Beach County -- where foreclosures have spiked -- the average loan on homes going into foreclosure has been something like $255,000. That's in Palm Beach County for goodness sake, one of the pricier real estate markets anywhere -- and where $255,000 is hardly plush territory.


McLean, Va.: The problem with the risk mitigation model underlying securitization of mortgages is that it rests on the assumption that mortgages comprising the collateralized debt obligation or related derivative are evaluated fairly and objectively and that, once evaluated, the risk of default within a particular tranche follows a normal distribution. The former assumption is specious when rating agencies have no skin in the game, and the latter assumption is specious when lenders have no skin in the game. In other words, the risk mitigation model on which CDOs are based has been shown to be a fantasy.

Kathleen Day: You got it, with no fairy godmother -- except the Fed -- to come to the rescue.


McLean, Va.: A major aspect of the housing bubble that you did not address in your article was the lack of attention given to it by mainstream media, including The Washington Post, during the bubble inflation of 2003-late 2005. During that time a number of intelligent, well-informed bloggers seemed to be the only voices identifying the housing bubble as a major problem of the near future. I see the lack of attention given to the buildup of the housing bubble to result at least partially from the conflict of interest between the revenue stream from real estate advertising and the responsibility to point out dangerous trends in real state pricing and financing. Major print media, including The Post, apparently did not want to look at the potential hit to their advertising revenue if their reporters wrote about the real estate bubble.

Kathleen Day: It wasn't just The Post, but all the major newspapers just about, and I don't think it was overlooked because of advertising revenue. And by the way, there were plenty of smart people at every major paper I can think of sounding the alarm, but it's hard to see a problem when everything seems on the surface to be going along rippingly. That said, you are right. Once again the media was slow off the mark.


Rockville, Md.: In an "ideal world" one would expect a variable rate mortgage to be restricted to a person of means. If rates went up, they would be able to afford the increase. The last person to get one would be a poor person. Really, that does make sense if you see the mortgage as a risk when the rates could change upward so far. But we seem to have saved them for the poor. How did this happen?

Kathleen Day: Greed and an assumption that those most vulnerable wouldn't be able to protect themselves either because they lacked the knowledge or the means.


Wokingham, U.K.: Do you think that this situation shows that the Eurozone, whose currency has appreciated so much against ours in the proudly deregulated Anglo-Saxon world recently, has shown that its more statist and pro-regulation approach is fundamentally better?

Kathleen Day: Again, I don't think deregulation is the problem -- lack of supervision was the problem. People can drive cars wherever they want, but imagine if there were no speed limits or lights. Or, more analogously, imagine there are speed limits and lights but no one enforces either. Do you think there would be more accidents? Of course there would be, especially if everyone hitting the pedal on the freeway knew there was no enforcement. They would drive faster and more recklessly even though doing so runs counter to their long-term well-being because it increases the chance they will be in an accident.


Washington: In fairness to the mortgage lender in Fairfax, Va., when a loan is a "stated income" loan, you need to acknowledge that it is not the job of the lender to verify income. That's why the loan is "stated income." It is, however, the job of the lender not to enable fraud on the part of the borrower. However, the stated income programs developed on Wall Street not only opened the door a crack, but in essence encouraged fraud via the institutional sin of omission/looking the other way.

Kathleen Day: That's very convenient. The lender announces it's no longer his job to verify income and, voila, that makes it so? I sure don't want to invest in a company that would lend my money that way. Common sense tells you that's foolish -- don't need a Harvard MBA to figure that out. And again, if that's not a practice destined to undermine the safety and soundness of lending institutions I don't know what is. Hello, regulators?


New York: Kathleen, as you've pointed out, the subprime mess is full of villains. I've been wondering why Robert Rubin has seemed to escape the wrath of the public and Citi shareholders? Bob was the chairman of the executive committee, and has been pulling in an eight-figure salary for many years. He was at the forefront when Citi was recklessly lending and recklessly securitizing.

Bob's so-called defense -- that he wasn't in charge of trading or risk -- seems hardly credible; he's a knowledgeable Wall Street insider. I think an eight-figure salary doesn't justify a "see no evil, hear no evil, speak no evil" approach. Are you paid the big bucks do to something? I couldn't have done a worse job, even if I tried.

Kathleen Day: I don't know about Rubin. I have said for a while that for half of what companies were paying these people, I could have done just as bad a job and saved everyone lots of money.


Upper Marlboro, Md.: What do I do? What do I do? I own a home that I purchased for $150,000 more than I can now sell it for. I knew it was overpriced when I bought it in 2005, but as a newly divorced person, I needed a home and was trying to buy one before townhouses became $1 million dollars. I thought just like everyone else that housing prices would continue to go up and I would be priced out. Now I don't want to pay $150,000 more than it's worth, and I seriously am considering walking away and letting it foreclose.

Out of 70 houses in my neighborhood, 10 are foreclosed and another 30 are being rented. Only 30 of us actually own our homes, and we are angry that we paid too much. What do we do? Those of us who have great credit and make a good living but know we are paying too much for our homes, do we walk away, take the credit hit and purchase when we rebuild our credit? I never can recoup $150,000 -- it will take at least 10 years, if not longer. Do you have any suggestions?

Kathleen Day: When a tidal wave of financial distress hits like this, everyone gets hurt and, like in your case, there's not a good answer. Tens of millions of homeowners around the country who will not face foreclosure nonetheless will be seeing property values fall by more than $350 billion because of foreclosure in neighboring houses. That's on top of declines from the bubble bursting in the first place. It's a mess.


Laurel, Md.: To what extent were subprime loans marketed as an affinity scam? Many African Americans (with some justification) believe that current socioeconomic disparities are rooted in discriminatory real estate practices from 1945 to 1965, during which many suburbs were built and then sold under racial covenants. Were a lot of subprime loans marketed as an opportunity for advancement, in some twisted way?

Kathleen Day: The Bush administration and industry touted subprime as, among other things, a way to open doors for minorities. Any time anyone talks about new rules to end the practices like kickbacks to brokers of subprime loans, the industry trots this argument out again -- oh no, they say, new rules will dry up credit to the people most in need (the industry has dried up credit very well on its own, thank you). But when anyone talks about helping distressed borrowers, suddenly the industry talks about these same people as "speculators" who deserve no help.


Maryland: You state in your article that six out of 10 people do not knowingly pay more for a product. Given your assertion, how do you explain the particularly American penchant for Starbucks $4 coffee over $1 gas station coffee, buying items at full price instead of waiting for a sale, or the wide disparity people pay for big-ticket items such as used cars?

I agree that people, if spoon-fed information, generally will choose the cheaper option -- but it appears that many people do not take the effort to educate themselves on their biggest purchase, their mortgage. How can you hold blameless these 60 percent of mortgage holders who didn't do the research needed to get the lower rate for which they were eligible?

Kathleen Day: A $4 cup of coffee is a luxury many can afford; paying hundreds of thousands of dollars extra in interest when you don't have to is something few can afford. The dynamics are simply different depending on the price category you consider. But at least I know when I go into Starbucks I can see clearly what I will be expected to pay. In the subprime market there is little market transparency and lots of subterfuge. Teaser rates, for example, often were stated without taxes and insurance figured in, so borrowers mistakenly thought their monthly payments would really be lowered by the new loan. It would be great if mortgages in the subprime market had been sold the way Starbucks sells coffee, with clear, easy-to-understand price tags.


Response to Lender: Your comments were right on -- the lender should have verified the income. Not only that, but it was probably the lending company that inflated the income to $200,000 in order to secure the loan. I know that lenders were altering the numbers, adding income, etc., to make the loans work. And let's not forget that it's not only subprime mortgage holders that are losing their loans -- what about those people who put 20 percent down on a house that has depreciated 35 percent in value? That person is now upside down on their house and has "lost" their 20 percent equity!

Kathleen Day: There is lots of evidence that brokers/lenders changed stated incomes without the borrowers knowing.


Baltimore: Kathleen: The comment by the mortgage broker was hilarious, as if he were under no obligation at all to determine if a buyer makes enough money to carry a loan. In 2000, before the homebuying frenzy really kicked off, I signed a contract for a $90,000 row house in Baltimore. I was self-employed, so the lender asked for two years of tax returns, savings account statements, IRA statements and other documents to prove that I actually could pay a $700-a-month mortgage. A few years later, mortgage brokers were getting $500,000 loans approved with no income verification. And we wonder why things blew up?!

Kathleen Day: I agree. If there's no obligation to verify anything, then the broker becomes a glorified scribe. That's a very expensive, inefficient way to fill out a form.


Washington: If I buy a product from a wholesaler and sell it to customers with a markup that I determine in my discretion, am I engaged in a kickback scheme? You seem to be in the camp that wants to ban any compensation paid to mortgage brokers. Putting aside the issues of loan suitability, etc., do you really think that we ought to dictate the terms of this commercial relationship?

Kathleen Day: When you pay an agent a bonus for steering someone into a higher-priced product than they need and then charge the borrower unbeknownst the cost of that bonus, then yes I would say that's a kickback, and I bet most consumers would too if they understood the mechanism at work. Bear in mind, these kickbacks didn't occur in the prime market, where there's price transparency.


Interest-Only and Loving It: Just curious why you chose to omit the role of the borrower in your article? Doesn't common sense tell someone making $38,000 a year that a $600,000 mortgage is not the proper debt level for him/her? What about the role played by the media? Where was The Washington Post Saturday Real Estate section screaming about how bad these loans were in 2002? They had a bunch of articles on how to spend your money. HGTV? Flip this, flip that? All contributed to the frenzy.

The media, the borrowers, the lenders, the tranche creators, the CDO buyers, even Freddie and Fannie all are guilty of the same thing -- greed. When you stop presenting this from an anti-Bush, anti-business viewpoint, we can get down to the task of solving it. My first thought would be to provide tax incentives for mortgage-backed security buyers, so we can get the capital markets loosened up again. Get people refinanced into sensible mortgages that are right for them.

Kathleen Day: Hey, when people tout personal responsibility they ought not be let off the hook when it turns out they didn't follow their own advice. You can call it finger-pointing if you wish, but I hear that mostly from people who don't want to rehash history for fear of embarrassment. Understanding what happened, how, and by whom is a first step in trying to ensure we avoid a repeat.


McLean, Va.: So you're telling me that people can't read a HUD-1? If you're incapable of understanding a HUD-1, you're incapable of carrying a mortgage for a house.

Kathleen Day: Interesting. The head of HUD under Bush, after closing on a house in the D.C. area, said he couldn't understand the papers he was given at signing -- and, he pointed out, he's a lawyer!


New York: Hi Kathleen -- great to see you're exposing these people again. For several years I have been trying to FOIA OTS for documents. They are claiming confidentiality, even on failed institutions. Were you aware of the February 2007 ski trip/conference sponsored in part by Countrywide? The OTS official who attended came back and signed off on the Countrywide charter. An OTS official attended and I have been faxing Congress and OTS on these issues for about 18 months. Ironically, as vice president, the first Bush was in charge of deregulating the Savings and Loans.

Kathleen Day: Don't know about that, but if true I'm sure some reporters would.


Kathleen Day: We've gone over our hour already. Great questions. Clearly emotions run high on this, and with good reason. Thank you all for a great session.


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